Splits v/s Buybacks

I have been monitoring this stock for a while, till yesterday it was priced around 10$ per share. Today it is trading around $5. What happened ? Did the shorts win big time today. But there is no bad news ? As you read up more about the stock you realise the company has opted to split its shares. So what is splits, and why do companies split their stock price ? If this interests you, keep reading…

What are Splits ?
A company whose stock is performing very well may opt to split its shares, distributing additional shares to existing shareholders. The most common split is 2:1, in which each share becomes two shares. The price per share immediately changes to half. Reverse split is when the number of shares decreases, ie 1:2

Why do companies opt for splits ?
A company will usually decide to split its stock if the price of the stock gets very high. High stock prices are problematic for companies because they make it seem as though the stock is too expensive. By splitting a stock, companies hope to make their position more attractive, especially to those investors that could not afford the high price. Stocks can be split 2:1, 10:1, or in any ratio the company wants.

Example: Say you own 100 shares of stock in ABC Corp. priced at $10 per share. ABC Corp. decides that $10 per share is too high of a price for its stock, so it issues a 2:1 stock split. This means that for every share that you previously owned, you now own two shares, giving you 200 shares. When the stock splits, the price will be cut in half (ie $5) since it is a 2:1 split. The investment you made will be the same, in effect, nothing has changed from your perspective.

But although technically nothing changes for the investor during a stock split, in reality often times there are changes. Not only does the split tend to increase demand for shares by making the shares more accessible to small investors, it also catches media attention. This tends to cause the price of a stock that has split to increase after the split. The split is interpreted by some as a sign that the company’s management is confident that the stock’s price will continue to rise.

What are Buybacks ?
A buyback is when the company decides to repurchase the stocks it had previously issued. In the case of stocks, this reduces the number of shares outstanding.

Why do companies opt for buybacks ?
Companies may decide to repurchase stock for many reasons. They may be attempting to improve the price to earnings (P/E) ratio by reducing market capitalization, or they may want to offer the stock as an incentive to employees . This is usually considered a sign that the company’s management is optimistic about the future and believes that the current share price is undervalued.

Recommendation: Personally i like splits. More than once i have seen the stocks that have split have always gone up. One stock that i follow opted for split in July 06. After the split the stock has jumped up. I am talking about Infosys Technologies Ltd. (INFY)

Leave a Reply

Your email address will not be published. Required fields are marked *